Baldwin Bicycle Company

Referring to the income statement as of 31st December 2016, we assume the Baldwin will retain the net income margin of 2.35% and pay corporate tax rate of 46.09%. Therefore, the net income is calculated from Baldwin bike sales plus contribution from Hi-Valu contract and this shows an incremental value in absolute profit to a total of $409,465.88, calculated as follow:

[pic 8]

Table 6: Net Income with Hi-Valu Contract

- Return on sales (ROS)

Profit alone is not sufficient to demonstrate how efficient Baldwin is generating revenue from this agreement, therefore ROS ratio provides insight into how much profit is being produced per dollar of sales. From the table, the ROS for Baldwin shows an increase from 2.35% to 3.33% ($409,465/ $12,307,250.00), signaling an improvement in operational efficiency.

(c) Return on assets

We assume there is no change to Baldwin’s bike existing total assets. With the addition of Hi-Valu asset-related costs, there is an increment in the new total assets to $8,827,537.50. Using the net income generated earlier, the ROA shows an improvement from 2.90% to 4.64% (shown in table). This further demonstrates that the contract with Hi-Valu, will result in more efficient utilization of Baldwin’s assets to generate earnings.

[pic 9]

Table 6: Return on Assets with Hi-Valu Contract

- Return on equity (ROE)

We assume the equity for current year to be an addition of previous year’s equity plus the net income from Baldwin’s bike. In addition, we need to consider the income we will receive from Hi-Valu contract as part of owner’s equity. The ROE shows an improvement from 7.03% to 11.66%, showing a better return of profitability over the amount of investment into the business.

[pic 10]

Table 7: Return on Equity with Hi-Valu Contract

6. What are the strategic risks and rewards?

There are quite a few strategic risks involved for Baldwin bike to take on Hi-Valu’s offer from a competition standpoint. In terms of pricing, Baldwin bikes are priced higher compared to Hi-Valu for the same above average quality segment. Customers who shop around for deals may feel that Hi-Valu bikes offer better value for money compared to a similar quality bike. In view of this, Baldwin had forecasted some market cannibalization from their regular sales volume and expect the loss to remain constant for the next 3 years. This is because they are confident that different distribution channel used by Hi-Valu, which is its own department store chain will not compete with their independent retail distribution. In addition, they believe their distributors have a strong distribution activities in Hi-Valu’s market region and this will ensure their market share is protected. However, Balwin bike had to take precaution to ensure their current dealers do not discover that they are also supplying to Hi-Valu, which will inadvertently compete for customers. In addition, Hi-Valu product specifications also involves higher carrying cost of inventory and receivables, which could lead to a potential cash flow issue as receivables may be too slow to cover subsequent production runs.

By accepting the Hi-Valu deal, Baldwin will increase its production capacity and this may result in higher potential profits. This agreement indirectly helps Baldwin to expand into new market segment as they have never penetrated the affordable segment in department store chains. The exclusivity and guaranteed supply quantity of 25,000 bike a year could temporary reduce their exposure caused by the poor economy. The year-to-year contract extension and 6 month’s termination notice is favorable to Baldwin should they see a spike in demand for their bikes as forecasted. This provides them an option to prematurely terminate their contract with Hi-Valu to return selling their more profitable range.

- What should Ms. Leister do? Why?

Ms. Leister should consider getting into an agreement with Hi-Valu in view of the current economy situation and declining demand for their bicycles. The offer from Hi-Valu provides Baldwin the opportunity to use its excess capacity to generate more sales. As the fixed cost for their production activity remains the same and unaffected by volume, Baldwin can achieve economies of scale when it produces more bicycles and spread the same amount of fixed cost over a larger number of units sold. Therefore, the price per bike of $92.29 offered by Hi-Valu is a key consideration to determine if the proposal makes financial sense after deducting the variable and other asset-related costs. Based on calculation, Hi-Valu bikes will contribute additional net income after tax of $149,545.35 and after considering cannibalization of its own sale of bikes. Besides, Hi-Valu is willing to sign an exclusivity contract with Baldwin for 3 years with an option to for both parties to either automatically extend on year-on-year basis or terminate the contract by providing 6 months’ notice. This gives Baldwin an exit strategy should the deal work unfavorably for the own bike range and make this into a one-time special order for Hi-Valu. Ms. Leister should consider a few legal clauses to be added into the contract before proceeding. One, to protect the intellectual property of their designs for Hi-Valu bikes to prevent similar production in other factories. Second, a non-disclosure clause to ensure confidentiality of their supply.